DEPARTMENT OF THE TREASURY INTERNAL REVENUE SERVICE ...

DEPARTMENT OF THE TREASURY

I N T E R N AL R E V E N U E S E R V I C E

WASHINGTON, D.C. 20224

OFFICE OF

CHIEF COUNSEL

October 1, 2002

Number: 200303021

Release Date: 1/17/03

International

POSTF-110034-02

UILC: 985.00-00

INTERNAL REVENUE SERVICE NATIONAL OFFICE LEGAL ADVICE

MEMORANDUM FOR WILLIAM BISSELL

SENIOR ATTORNEY LARGE & MIDSIZE BUSINESS

FROM:

Jeffrey Dorfman

Chief, Branch 5, Office of Associate Chief Counsel

(International)

SUBJECT:

This Chief Counsel Advice responds to your memorandum dated June 4,

2002. In accordance with I.R.C. ¡ì 6110(k)(3), this Chief Counsel Advice should not

be cited as precedent.

LEGEND

Parent

Taxpayer

FSub

Country A

Currency A

Number R

Amount A

Amount B

Amount C

Rate X

Rate Y

Date 1

Date 2

Date 3

Date 4

Date 5

=

=

=

=

=

=

=

=

=

=

=

=

=

=

=

=

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POSTF-110034-02

ISSUE

Whether Taxpayer¡¯s United States dollar basis of FSub shares acquired from

Country A shareholders in a tax-free reorganization described in section

368(a)(1)(B) must be determined with reference to the United States

dollar/Currency A exchange rates in effect on the dates on which the Country A

shareholders acquired their FSub shares in section 351 nonrecognition

transactions, or with reference to the exchange rates in effect on the date of the

tax-free reorganization when Taxpayer acquired the FSub shares from the Country

A shareholders.

CONCLUSION

Taxpayer¡¯s United States dollar basis of the FSub shares it acquired from the

Country A shareholders must be determined with reference to the United States

dollar/Currency A exchange rates in effect on the dates on which the Country A

shareholders acquired their FSub shares.

FACTS

During all relevant time periods, Taxpayer was a United States corporation

and a wholly-owned subsidiary of Parent, also a United States corporation.

Taxpayer¡¯s functional currency was the United States dollar. On Date 1, Taxpayer

and R investors, who were residents of Country A, formed FSub, a corporation

organized pursuant to the laws of Country A.

In connection with the formation of FSub, Taxpayer and the R Country A

investors each contributed Currency A to FSub in exchange for FSub stock in a

section 351 transaction in which no gain or loss was recognized. Specifically, on

Date 2, Taxpayer contributed to FSub Currency A then worth Amount A as well as

property located in Country A then worth Amount B. Taxpayer recorded its basis in

its FSub stock and kept its books in United States dollars. Also on Date 2, the R

Country A investors contributed to FSub Currency A then worth a total of Amount A.

On Date 2, the exchange rate with respect to the United States dollar was Rate X.

From Date 3 through Date 4, both Taxpayer and the R Country A shareholders

made additional capital contributions to FSub, in each case in exchange for

additional FSub stock. We assume for purposes of the analysis set forth herein

that these additional capital contributions also qualified as section 351 transactions

in which no gain or loss was recognized.

On Date 5, Taxpayer acquired all of the FSub stock held by the R Country A

shareholders in exchange for Taxpayer¡¯s voting common stock worth Amount C in a

reorganization transaction described in section 368(a)(1)(B). We assume for

purposes of the analysis set forth herein that this reorganization qualified as a

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POSTF-110034-02

nonrecognition transaction. On the date of the reorganization, the Currency A

exchange rate with respect to the United States dollar was Rate Y.

LAW AND ANALYSIS

Generally, United States tax concepts apply to determine the tax

consequences of events even if those events occur outside of the United States

and even if those events result from activities conducted by foreign persons.

United States v. Goodyear Tire and Rubber Co., 493 U.S. 132, 145 (1989), reh¡¯g

denied, 493 U.S. 1095 (1990); Biddle v. Commissioner, 302 U.S. 573, 578 (1938).

See also Untermyer v. Commissioner, 59 F.2d 1004, 1005 (2nd Cir. 1932), cert.

denied, 287 U.S. 647 (1932); Rev. Rul. 73-254, 1973-1 C.B. 613; Rev. Rul. 64-158,

1964-1 C.B. (Part 1) 140. This controlling aspect of United States tax concepts

similarly applies to determinations of basis for property acquired by foreign persons

outside the United States. See, e.g. Reisner v. Commissioner, 34 T.C. 1122

(1960), acq., 1961-2 C.B. 5.

Section 1011(a) provides that the adjusted basis of for determining gain or

loss from the sale or other disposition of property, whenever acquired, shall be the

basis of such property determined under section 1012 or other applicable

provisions of the Code, including subchapter C, adjusted as provided in section

1016.

Under section 358(a)(1), in the case of a section 351 exchange in which no

gain or loss is recognized, the basis of the property permitted to be received under

such section without the recognition of gain or loss is generally the same as that of

the property exchanged.

Under section 362(b), if property is acquired by a corporation in connection

with a tax-free reorganization, the recipient¡¯s basis in such property is generally the

same as it would be in the hands of the transferor, increased in the amount of gain,

if any, recognized to the transferor on such transfer. Thus, in the case of stock

received in a reorganization described in section 368(a)(1)(B) in which no gain is

recognized, the recipient¡¯s basis in such stock is equal to its basis in the hands of

the transferors immediately before the transaction.

Rev. Rul. 78-281, 1978-2 C.B. 204, provides that the basis of property

purchased by a U.S. corporation with foreign currency borrowed from a foreign

bank must be determined by reference to the exchange rate in effect on the date of

purchase, and that the basis of the purchased property cannot be adjusted for the

purpose of reflecting subsequent fluctuations in the United States dollar value of

the borrowed foreign currency.

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POSTF-110034-02

Rev. Rul. 54-105, 1954-1 C.B. 12, states that for purposes of determining

gain, the basis and selling price of property acquired by a U.S. citizen living in a

foreign country should be expressed in United States dollars at the rates of

exchange prevailing as of the dates of purchase and sale of the property,

respectively.

In a series of cases decided under section 127(a) of the 1939 Code, the

appropriate method for determining the amount of the deduction for losses resulting

from the destruction or seizure of property during war was addressed. These cases

involve foreign property purchased (or inherited) by a nonresident alien with foreign

currency. For example, in Heckett v. Commissioner, 8 T.C. 841, 847 n.6 (1947),

acq. C.B. 1947-2, 2, the court stated that the taxpayer would have to translate the

cost basis of property acquired with foreign currency into United States dollars at

the exchange rate in effect at the time of purchase. Similarly, in Abraham v.

Commissioner, 9 T.C. 222, 226 (1947), acq. in part and nonacq. in part C.B. 19481, 1, 4, the court applied the exchange rate in effect at the time of purchase in

determining the United States dollar basis of property acquired with foreign

currency. In Gutwirth v. Commissioner, 40 T.C. 666 (1963), acq. C.B. 1966-2, 5,

the taxpayer transferred assets acquired with foreign currency to a New York law

firm. The court stated that because the basis of each transferred asset was not

converted into United States dollars using the rate of exchange in effect at the time

the property was originally acquired or constructed, the figures reflected on the

books of the law firm did not represent the true cost of the assets in United States

dollars. See also Ternovsky v. Commissioner, 66. T.C. 695 (1976); Elek v.

Commissioner, 30 T.C. 731 (1958); Daniel v. Commissioner, 19 T.C.M. (C.C.H.)

1521 (1960).

Recently, in Travelers Ins. Co. v. United States, 2002 U.S. App. LEXIS 19056

(Fed. Cir. 2002), the Federal Circuit Court of Appeals addressed the basis

translation issue in the context of former section 805. Under former section

805(b)(4)(B), the amount attributable to an asset for purposes of determining the

adjusted reserves and earnings rates of a life insurance company was its adjusted

basis. The government argued that former section 805(b)(4)(B) dictated that the

taxpayer use historical exchange rates to translate the adjusted basis of certain

Canadian dollar denominated bonds, mortgages, and other assets into United

States dollars. The court held that although the language of section 805 did not

dictate the use of historical exchange rates, ¡°the IRS could properly, as an exercise

of discretion, require use of historical exchange rates . . ..¡± Id., 2002 U.S. App.

LEXIS at 33.

In the present case, Taxpayer acquired FSub shares from R Country A

shareholders in a reorganization described in section 368(a)(1)(B) in which no gain

was recognized. Accordingly, under section 362(b), Taxpayer¡¯s basis in such stock

is equal to its basis in the hands of the R Country A shareholders immediately

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POSTF-110034-02

before the transaction. The R Country A investors made contributions of Currency A

to FSub in exchange for FSub stock in section 351 transactions in which no gain or

loss was recognized. Even though these events occurred outside of the United

States and resulted from activities conducted by foreign persons, United States tax

concepts must be applied in determining the basis of the FSub stock acquired by

the Country A investors. Accordingly, the basis of the FSub stock originally held by

the R Country A investors must be determined under section 358(a)(1).

Under section 358(a)(1), in the case of a section 351 exchange in which no

gain or loss is recognized, the basis of the property permitted to be received without

the recognition of gain or loss is generally the same as that of the property

exchanged. The Currency A basis of the Country A investors in their FSub shares

will thus be equal to the amount of Currency A contributed. Given the rulings and

cases set forth above, we believe that absent specific administrative guidance to

the contrary, the exchange rates required to be used to determine the United States

dollar basis in their FSub shares are the respective exchange rates on the dates

that the Country A investors originally acquired such shares. On Date 2, the date

on which the Country A investors contributed Currency A worth a total of Amount A

to FSub in exchange for FSub stock, the exchange rate was Rate X. Accordingly,

Rate X must be used to translate the Amount A of Currency A into United States

dollars. In the case of each additional contribution of Currency A by the Country A

investors to FSub, the exchange rate on the date of each such contribution must be

used to translate the amount of Currency A contributed to FSub on that date into

United States dollars. Rate Y, the exchange rate in effect on Date 5, the date of

the reorganization, is not to be taken into account.

This writing may contain privileged information. Any unauthorized disclosure

of this writing may have an adverse effect on privileges, such as the attorney client

privilege. If disclosure becomes necessary, please contact this office for our views.

Please call if you have any further questions.

Jeffrey Dorfman

By:

JEFFREY DORFMAN

Chief, Branch 5

Office of Associate Chief Counsel

(International)

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